Low Rates Lead To Pension Woes, LBOs

By Michael Aneiro

Today’s Wall Street Journal offers some food for thought for bond investors. The front page kicks things off with a story by Mike Ramsey and Vipal Mongal exploring how low bond yields are forcing corporations to pour more money into their pension funds:

[Ford Motor Co. (F)] is one of a who’s who of U.S. companies pouring cash into pension plans now being battered by record low interest rates.Verizon Communications Inc. [VZ] contributed $1.7 billion to its pension plan in the fourth quarter and—highlighting companies’ sensitivity to this issue—Boeing Co. [BA] now reports “core earnings” to separate out pension expenses.

“It is one of the top issues that companies are dealing with now,” said Michael Moran, pension strategist at investment adviser Goldman Sachs Asset Management.

The drain on corporate cash is a side effect of the U.S. monetary policy aimed at encouraging borrowing to stimulate the economy. Companies are required to calculate the present value of the future pension liabilities by using a so-called discount rate, based on corporate bond yields. As those rates fall, the liabilities rise.

The story points out that the same companies have also been huge beneficiaries of low interest rates when it comes to their ability to borrow cheaply, sometimes directing the proceeds from bond sales toward their own pension funds.

Moving to the front page of the Money & Investing section, Patrick McGee and Matt Wirz report that a resurgent market for leveraged buyouts is causing some fund managers to check their portfolios for investment-grade bonds of likely LBO targets, namely cash-rich companies with depressed share prices:

When private-equity firms purchase a company in a “leveraged buyout,” or LBO, they stuff it with debt to reduce the cash they have to use in the takeover. The debt burden, in turn, can lead to a downgrade of the company’s bonds, sending their price lower and causing losses in investors’ portfolios. Some bond investors cut their exposure to target companies at the mere suggestion of a buyout.

The most recent, and high-profile, example of the trend came when Dell Inc.’s (DELL) longer-term bonds lost as much as 17% of their value shortly after reports emerged last month of a potential $23 billion buyout of the computer maker. The bonds now trade 14% lower than they did before the deal surfaced. That sent a wake-up call to bond-fund managers.

As perceptions of buyout risk grew in January, Eaton Vance (EV) took a hard look at its $5.7 billion of investment-grade bonds and cut exposure to possible leveraged-buyout targets whose debt it perceived as overvalued, such as oil servicer Nabors Industries Ltd.,(NBR) said Kathleen Gaffney, a co-director at the firm. “We cleared the decks,” she said.

Finally, in a special section on investing in funds and ETFs, Tom Lauricella talks to Dan Ivascyn, manager of the Pimco Income Fund (PONAX). You can read the interview here, and read this story when Barron’s profiled Ivascyn last July.

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